How to index small cap premium erosion
According to Joachim Klement, Strategy Director at Panmure Liberum, the small paper premium is “very likely to be dead,” and the force that once drove it is “disappearing or overwhelmed.”
Talk in ETF StreamThe event of the 2025 ETF Ecosystem Unwrap event, Cumented argued that the rise of index investments “created a self-enhancing loop in which the biggest stocks are growing and growing, and small-cap premiums are eroded.”
Small cap Premium is about the historical trend in which small caps outweigh larger stocks over time. but, ETF Stream I explored last yearThis phenomenon has been weak since the 1980s, especially in the past decade.
For Klement, the timing of its disappearance is no coincidence. It was closely linked to the rise of benchmarks and index investments.
This change in approach from the investment community has created an environment in which small caps exhibit lower demand resilience than large caps.observation I also created Mike Green from Asset Management in a recent interview with Simplify. ETF Stream.
Essentially, benchmarked investors are forced to hold the largest shares on scale. “Trust me, the risk team doesn’t like it,” quips Clemen.
Given the decline in elasticity, the price of large caps increases with each marginal dollar to the stock market, creating a “self-enhancing” cycle of size size.
For further evidence, Klement highlighted research showing that the “index content ratio” is a member of inventory, in other words, a member of the stock, a member of the seven grand index.
Chart 1: Index Inclusion Effect, 2000-2021—Source: Behmaram (2023)
Index Inclusion “creates automatic purchases that are more valuation-independent. They are more expensive. They are artificial demand,” explained Klement.
“In this study, we modeled counterfactuals. What happens if there’s no flow in index funds and ETFs over the past 25 years?
Despite the evaporation of small premiums, Cumentation believes they still play a key role in a diverse portfolio.
One is that “they tend to get out of the recession as they are more agile and quicker to adapt to changing conditions… This cyclical behavior offers the advantages of diversification, and provides active allocators with the opportunity to adjust their exposure over time.”